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Jeff Frankel repeats his call for NGDP targeting

“Monetary policymakers in some countries should contemplate a shift toward targeting nominal GDP – a switch that could be phased in gradually in such a way as to preserve credibility with respect to inflation. Indeed, for many advanced economies, in particular, a nominal-GDP target is clearly superior to the status quo….

…A nominal-GDP target’s advantage relative to an inflation target is its robustness, particularly with respect to supply shocks and terms-of-trade shocks. For example, with a nominal-GDP target, the ECB could have avoided its mistake in July 2008, when, just as the economy was going into recession, it responded to a spike in world oil prices by raising interest rates to fight consumer price inflation. Likewise, the Fed might have avoided the mistake of excessively easy monetary policy in 2004-06 (when annual nominal GDP growth exceeded 6%)…

…The idea of targeting nominal GDP has been around since the 1980’s, when many macroeconomists viewed it as a logical solution to the difficulties of targeting the money supply, particularly with respect to velocity shocks. Such proposals have been revived now partly in order to deliver monetary stimulus and higher growth in the US, Japan, and Europe while still maintaining a credible nominal anchor. In an economy teetering between recovery and recession, a 4-5% target for nominal GDP growth in the coming year would have an effect equivalent to that of a 4% inflation target.

Monetary policymakers in some advanced countries face the problem of the “zero lower bound”: short-term nominal interest rates cannot be pushed any lower than they already are. Some economists have recently proposed responding to high unemployment by increasing the target for annual inflation from the traditional 2% to, say, 4%, thereby reducing the real (inflation-adjusted) interest rate. They like to remind Fed Chairman Ben Bernanke that he made similar recommendationsto the Japanese authorities ten years ago…

…Shortly thereafter, projections for nominal GDP growth in the coming three years should be added – higher than 4% for the US, UK, and eurozone (perhaps 5% in the first year, rising to 5.5% after that, but with the long-run projection unchanged at 4-4.5%). This would trigger much public speculation about how the 5.5% breaks down between real growth and inflation. The truth is that central banks have no control over that – monetary policy determines the total of real growth and inflation, but not the relative magnitude of each.

A nominal-GDP target would ensure either that real growth accelerates or, if not, that the real interest rate declines automatically, pushing up demand. The targets for nominal GDP growth could be chosen in a way that puts the level of nominal GDP on an accelerated path back to its pre-recession trend. In the long run, when nominal GDP growth is back on its annual path of 4-4.5%, real growth will return to its potential, say 2-2.5%, with inflation back at 1.5-2%.

Phasing in nominal-GDP targeting delivers the advantage of some stimulus now, when it is needed, while respecting central bankers’ reluctance to abandon their cherished inflation target.

1 Comment

Benjamin Cole

Although I am thoroughly in the Market Monetarism camp, I do wonder about both the MM’s call for clear guidance from central bankers, and the hand-wringing by others that a central bank has to “maintain credibility.”

1. 97 out of 100 Americans could not pick Bernanke out of a line-up of NBA all-stars. They don’t know about monetary policy, or why it is important.Businesses hire and fire based on whether they have sales, not some posturing by a central banker. (Really, you economics types ned to visit a local bar every one in a while).

2. No government official in a modern, Westernized nation has any credibility. In what nation is not cynicism, distrust, skepticism the rule? And someone believes central bankers are going to be held in high regard? The public trusts bankers? In what country?

For these reasons, I think central bankers can only aggressively target growth through sustained QE, until results are obtained. Print money until is pouring over the transom in businesses, bars, car lots, housing developments etc. Go for boom times.

If no results are obtained, then we are radically curbing national debt through monetization.